Gold Is About To Be Under Major Selling Pressure, USD/CNY TO Break 7.00

It would take an extraordinary set of deflationary circumstances for the Federal Reserve to lower rates 75 basis points this year as the market is pricing in.

Market's expectations for a significant easing cycle by the Fed are unlikely to be met. Front-end treasury yields are likely to move higher, flattening the yield curve.

Gold acts as an inflation hedge and struggles to compete with rising yields. Gold prices are inversely correlated and derived from the expected-real-yield or nominal treasury yields minus inflation expectations.

Global growth is slowing, Chinese financial risk is high, inflation is subdued and treasury yields are still excessively low even if the Fed does cut 50 basis points this year.

As U.S. yields rise because of relative outperformance of the US economy, with the Fed not exceeding market expectations for 75 basis points of lower rates while disinflationary global cross-currents accelerate, gold will decline.

I would not underestimate how quickly the treasury market can reprice the path of monetary policy and I expect yields to move higher as the Fed undershoots market expectations for a 50bp-75bp lower Federal Funds rate. A July rate cut of at least 25 basis points is completely priced in at 100% chance. I would estimate the real probability to be 70% of a cut to 30% chance of no-move in either direction. This creates a very skewed risk of being long gold.

If the Fed does cut 25 basis points, there is no upside at this point as the market has already discounted 50-75 basis points of easing for the year and a supposed 100% chance of a July decrease. This is peak optimism and dovishness from the market regarding U.S. monetary policy relative to the health of the global economy. Gold has moved higher and yields lower on the market pricing in an easier path of monetary policy. Whether this actually occurs remains to be seen.

I am bearish on global growth, inflationary expectations and risk assets and the portfolio is positioned significantly net short specifically in the metals, energy and mining complex. I'm bullish on a select few assets, including European and Chinese bond prices and the U.S. dollar.

Federal Reserve chair, Powell, is well aware of global macro risk specifically emanating from the Chinese economy and a possible speculative attack on the Chinese yuan. I believe this is his main concern and why he is seemingly willing to lower the Federal Funds rate despite the U.S. economy performing at or slightly above trend with extremely low unemployment.

The U.S. dollar is likely to appreciate, driven by a relatively stronger US economy and relatively less easy monetary policy from the Fed compared to the ECB, Bank of Japan and PBOC. The lower interest rates from the Fed story is already completely priced in and largely overdone by the market. Unless you are expecting zero rates again and re-initiation of quantitative easing in the United States, which is highly unlikely, there is little upside on front end bond prices and gold prices. There is though, plenty of risks that market expectations of 75 basis points of easing this year are not met.

ECB officials are already debating how to further stimulate the eurozone economy and ease policy there, including restarting QE and deeper negative rates. The Fed is not anywhere close to this. The People's Bank of China (PBOC) would like to lower rates but is worried about igniting a speculative run on the yuan and investors can look back to late 2015-early 2016 to see the global ramifications on risk assets of significant yuan depreciation. I believe it is a matter of time before the USD/CNY breaks 7.00 and from there it is going higher. Whether it be from higher tariffs on Chinese exports, a stronger dollar due to the Fed undershooting easing expectations, a generally weaker Chinese economy, or all the above, it is simply not time at all to be long the yuan against the dollar.

The case that US treasury yields will at least stabilize (and potentially rise) while inflationary and global growth expectations continue to decline is strong. This increases the expected real yield. This is distinctly bearish for gold because gold is an inflation hedge and the opportunity cost of holding gold rises when treasury yields rise. It's difficult to anticipate lower yields in the US right now even if inflationary expectations moderately decline. It would require a very aggressive easing policy from the Fed, which would be a response to an extremely deflationary scenario and a U.S. recession, through which gold would probably decline short term until inflation expectations bottom out, while easier policy and a recovery set in.

In 2008, gold lost significant value in a short amount of time. There wasn't a safe haven bid as inflationary expectations went into free fall. QE and a zero interest rate policy saved it and the bar for this to happen again is very high. The more likely scenario is the US economic expansion continuing and disengaging from the macro environment with relative data outperformance while the global situation worsens.

Disclosure: I am/we are short CLR, FCX, VALE, WPM, RGLD, GOLD, PBR. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.